Oil Over $200? Not If, But When
Oil and natural gas prices have moved substantially higher. But exploration, production and service company stocks are trading as if the prevailing level of oil was commensurate with the $80 to $90 range for West Texas Intermediate Crude. Contrary to arguments frequently aired in mainstream media, this is not a speculative bubble. Oil will continue to surprise to the upside for the balance of this year.
It's normal to see producers and service company stocks lagging behind the underlying prices of oil and natural gas. This is a pattern we've seen throughout the entire bull market. Analysts and investors battle cognitive dissonance in the face of our inexorable energy crisis. Six months from now, current prices for exploration, production and service companies will be seen as bargains.
We're moving through what is commonly known as the "shoulder season," a time when energy demand is supposed to be seasonally weak. But rather than a brief respite before the North American driving and air conditioning season shifts into full gear, energy prices have done nothing but move higher. World demand runs at between 86 and 87 million barrels of oil equivalent per day and supplies barely match demand. Spare capacity is trivial, and entirely predicated on heavy, high sulfur oil which the world lacks spare refining capacity to process, along with natural gas condensates and refinery gains. World production of light sweet crude peaked in 2005 and it is only now that Wall Street is coming to terms with the fact that capacity gains are of lesser quality.
Oil's move comes as no surprise to us. We were on record early this year forecasting the current price level and beyond. The bottom-line is that the world is starting to come to terms with the phenomena commonly referred to as "peak oil." Wall Street number crunchers are now framing analysis to incorporate decline rates, spare capacity, supply and demand concepts in terms of flow rates per day and the challenges associated with the ramp of new oil production. They're starting to see the big picture and 2008 will see some of the sharpest gains yet in the energy bull market.
Natural gas should outperform oil over the next three to nine months. Chesapeake Energy Corp. and XTO Energy will directly benefit. Nabors Drilling has recently spiked on the back of firming natural gas prices. The stock lagged the service industry in general while North American natural gas drilling underwent a long inventory correction. The stock has much more room to run and trades at a low valuation relative to peak cycle earnings potential.
With other energy purchases, we're going to pick up shares of Petrobank. The stock offers exposure to Canadian oil sands, complimenting our large position in Encana. The company will also benefit as the recent excitement over the Bakken Oil Shale deposit spreads to Canada. Finally, we will increase our services industry exposure with diversified services provider Weatherford International and additional shares of Transocean, the single best value in the industry. Brazil recently announced they have locked-up 80% of the world's deep water drilling capacity in long-term contracts. The industry will be astounded by how long this cycle will run. Forward earnings estimates for Transocean have a long way higher to move - particularly for years 2010 and beyond.
Technology Catching A Bid; Global Economy Not Tanking
We're adding shares of Intel and Nokia to the portfolio. In our view, Nokia just hit a bottom and we're fearlessly going after the falling knife. Key supplier Texas Instruments reported favorable inventory trends and Nokia's shares have fallen to the point where they represent sound value in telecom. Many areas in the semiconductor space have turned around nicely, and are showing signs that the inventory overhang will be worked down. Our entry with ANADIGICS and Broadcom were superbly timed and while Intel will be a far more boring position, there's a time and a place for "boring."
Finally, we're adding shares of Brazilian base metals mining giant Valle - something we should have done months ago, but nevertheless the shares are still attractive
At the open, we will establish the following positions:
- Petrobank Energy and Resources (PBG: Toronto): Buy 200 shares at the open
- Chesapeake Energy (CHK: NYSE): Buy 200 shares at the open
- XTO Energy (XTO: NYSE): Buy 200 shares at the open
- Transocean Inc. (RIG: NYSE): Buy 100 shares at the open
- Nabors Industries (NBR: AMEX): Buy 300 shares at the open
- Weatherford International (WFT: NYSE): Buy 200 shares at the open
- Companhia Vale ADS (RIO: NYSE): Buy 300 shares at the open
- Intel Corp. (INTC: NASDAQ): Buy 200 shares at the open
- Nokia Corp. (NOK: NYSE): Buy 300 shares at the open
Please note: While the order to buy on the open for Petrobank is submitted before the market open Monday, it will execute on Tuesday, at the market open. Canadian stock markets are closed on Monday for the Victoria Day holiday.
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